Singapore banks are readjusting. In 2022, they benefited from fatter margins on rising interest rates. Now they face the second part of the story, when rates and inflation feed through to higher funding costs and lower loan appetite.

Overall, S&P Global Ratings believes profitability will remain good for Singapore banks in 2023. But margins will peak, and tepid loan growth will crimp further upside.

High Margins That Could Plateau

Net interest margins (NIMs) look set to peak this year after consecutive quarters of rising asset yields throughout 2022. Singapore's overnight and interbank rates have been rising in tandem with the U.S. Federal Reserve's hikes. Policy rates are also on the uptrend in all of the major overseas markets where Singapore banks operate, with the exception of China.

Singapore banks are well-positioned to take advantage of tightening cycles; the majority of their floating rate loans have quickly repriced upward, while their balance sheets remain flushed with liquidity and low-cost customer deposits. Acquisitions are also starting to pay dividends. For example, United Overseas Bank Ltd.'s integration of Citigroup's consumer portfolio in Malaysia and Thailand contributed to about 8 basis points (bps) of NIM uplift in the fourth quarter of 2022.

Chart 1

In our view, the upside on interest margins will likely start tapering and peak in the middle of 2023, in line with the likely cresting in the Fed's rate cycle. At the same time, funding costs are starting to catch up. Depositors have been shifting into higher-yielding fixed deposits, and the proportion of low-cost current and savings account (CASA) deposits has steadily declined over consecutive quarters (see chart 2).

Banks are also getting competition from Singapore treasury bills. Recent issuances of these 'AAA' securities have been yielding close to 4%, offering a compelling alternative to bank deposits. Singapore banks have responded by upping deposit rates, and not just on fixed deposits; for example, promotional CASA rates offer enhanced returns if certain conditions are met, such as salary crediting. Such trends will eat into margins.

Chart 2

Rate Hikes And Economic Issues Could Weigh On Credit Appetite

Borrowing appetite will likely moderate this year. We forecast loan growth in low-mid single digits in 2023. Systemwide gross loans for Singapore commercial banks have declined for three consecutive months since September 2022. This coincided with a spike in lending yields, which will continue to weigh on consumers and businesses this year.

Other weights on credit demand include property-cooling measures and recession risk for major economies. China's reopening will provide some offset.

Weaker momentum in Singapore residential property.  Measures including a lower loan-to-value limit for public housing loans may further dampen credit demand. Such measures were introduced last September and, coupled with rising mortgage rates, are already hitting prices for residential property. A benchmark price index for private residential property edged up 0.2% sequentially in the fourth quarter of 2022, down from 3.8% the previous quarter. The Housing Development Board's resale price index for its flats moderated to 2.3% growth in the fourth quarter, compared with 2.6% in the previous quarter. Slowing momentum in property prices could hinder demand for mortgage loans--which account for approximately a quarter of total loans in Singapore.

Uncertain global economic outlook.   Fears of recession in major economies present further downside risks to credit demand. Singapore's externally oriented economy relies significantly on final demand in the U.S. and Europe. Activity in these economies will likely slow later this year, weakening export demand for several key markets in the region (see "U.S. Business Cycle Barometer: Constrained By Tight Monetary Policy," published on RatingsDirect on Jan. 25, 2023).

The China cushion.   The country's reopening and rapid dismantling of its zero-COVID policy could offset some of the drag from the Western slowdown. Nonetheless, the net impact on export demand should generally be negative this year. This will dampen overall credit demand for Singapore banks. (see "Asia-Pacific In 2023: China Rebound Cannot Offset Western Slowdown," Feb. 23, 2023). That said, DBS Bank Ltd. and Oversea-Chinese Banking Corp. Ltd. (OCBC) could benefit more from China's reopening than peers, given their larger direct exposures and presence in the country.

Economic uncertainty and increased market volatility will also crimp fee income for banks. Singapore banks have been investing in their wealth franchises, leveraging on the city-state's status as a prominent offshore wealth management hub. The prevailing risk-off sentiment highlights inherent volatility in wealth-management income.

Chart 3

Resilient Asset Quality, Manageable Deterioration

The realities of higher borrowing costs, coupled with still elevated inflation, will register more prominently in 2023. This could result in some backsliding after last year's continued improvement in nonperforming loan (NPL) ratios. In 2022, new NPL formation was modest, and offset by recoveries and write-downs. Loan loss provision were also very low at about 14bps, better than pre-COVID levels.

Consumers and small and midsized enterprises (SMEs) typically bear the brunt of high input costs and interest rates. In our view, any deterioration in asset quality will be manageable, likely emanating from pockets of weaker or overleveraged borrowers as economic conditions get tougher.

Chart 4

Gross NPL ratios for banks could weaken slightly over the next 12-18 months. The banks also have exposure to economies in Indonesia and Thailand, where the level of restructured loans remains elevated post COVID. Loan-loss provision could tick up to 20bps-25bps, which is closer to normalized levels. We note that Singapore banks have been conservative in reversing management overlays made during the pandemic, and total provision coverage is over 100% of reported NPLs (and over 200% when considered the unsecured portion). This adds to their resiliency.

Table 1

Sound Fundamentals Underpin Ratings On Singapore Banks

Rates and global recession risk will dampen, but not derail, momentum. Singapore banks have adequate capitalization and good provisioning buffers to absorb changes in business cycles. They are also cushioned against idiosyncratic risks emanating from exposure to regional developing markets, including a wider range of GDP per capita, economic fundamentals, and macroeconomic dynamics.

Last year's sweet spot for Singapore banks led to generous payouts for the fiscal year, including special one-time dividends. Capital management has been a balancing act between prudence and efficiency; the former taking precedence during COVID, and the latter being more apparent during good times. We believe management will continue to exercise good judgment in both capital and risk management.

Table 2